CASE STUDY

Bharat Engineering Works (BEW) IS PROMOTED BY Mr. Bharat Singh, a qualified and experienced mechanical engineer. He worked for an automobile major General Auto Ltd (GAL). Over years of experience, he had dev eloped a sheet metal component that was being procured by GAL through another vendor. GAL was not satisfied with the quality of the sheet metal components. In view of the better product developed by Mr. Bharat Singh, his employer encouraged him to set up his own unit and assured him all help. He decided to venture on his own.

Bharat Singh prepared the project report. The project cost was Rs 60 lacs-consisting of Rs 40 lakhs towards plant and machinery and remaining Rs 20 lakhs as working capital. Mr. Bharat Singh with all his resources could accumulate only Rs 20 lakhs on his own and need balance Rs 40 lakhs as loan from a bank.

He approached his banker friend for a loan of Rs 40 lakhs. After due appraisal of the project and considering the assured orders from GAL, the bank agreed to provide him Rs 40 lakh. However, the bank was willing to disburse the fund on a need-based basis according to the requirement of funds as they arise. The bankers asked Bharat Singh to prepare the requirements of funds according to the time when the funds were actually required.

Bharat Singh had negotiated the contracts for machinery on deferred payment basis. On the recommendations of his employer, the machinery supplier had agreed for the deferred terms of payment as follows:

Down payment: Rs 10 lakh

After one year: Rs 20 lakh plus interest @ 15% on remaining amount

After two years: Rs 10 lakh plus interest @ 15% on the remaining amount.

Accordingly, the following requirement of fun was presented to the bank to which the bank agreed:

Rs (lakh) Year 0 Year 1 Year 2 Total

Funds required 30.00 20.00 10.00 60.00Equity 20.00 ------ ----- 20.00loan 10.00 15.00 15.00 40.00

The bank sanctioned the loan on the following terms:

1. The rate of interest would be 12% per annum.2. The aggregate period of the loan would be 7 years from now.3. The loan would have moratorium of two years from date of sanction.4. The repayment could be done in any of the following methods:

(a) In equal amount every quarter for 20 years along with interest beginning year 3 onwards on declining basis.

(b) In equated quarterly installments (EQIs) for 20 quarters commencing from Year 3.

Moratorium of two years was given because BEW did not have enough generation in the first two years. However, BEW would pay the interest during the period.

Your are required to find the following repayment cash flows of the BEW for 20 quarters from Year 3 onwards under declining basis as in 4(a) above.

Also explain if BEW choose the option of EQI as in 4(b), answer the following:

1. Work out the EQIs for next 20 quarters for repayment of loan and interest.

2. BEW is required to show interest portion of EQIs in its profit and loss account each year. Find out the amount of interest in each EQI and the sum that would be sown as interest each year.